Tài chính doanh nghiệp - Chapter 15: Foreign exchange market: participants and mechanics

Chapter 15Foreign Exchange Market: Participants and MechanicsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonLearning ObjectivesIdentify participants in foreign exchange (FX) marketsDescribe functions and operations of FX marketsOutline instruments traded in FX marketsExplain conventions for quotation and calculation of exchange rates and forward exchange rates Identify participants in foreign exchange (FX) marketsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.1 IntroductionFX markets comprise all financial transactions denominated in foreign currency, currently estimated to be USD1.5 trillion per dayFacilitate exchange of value from one currency to anotherInternationally adopted FX market conventions to improve market functionalityCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.2 FX Market ParticipantsFX market participants can be classified asFirms conducting international trade transactionsFX dealersCentral banksInvestors and borrowersSpeculative transactionsArbitrage transactionsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonFirms conducting international trade transactionsExporters receive foreign currency for the sale of their goods and servicesExporters use the FX market to sell foreign currency and buy AUDImporters use the FX market to buy foreign currency (sell AUD) to be used for purchasing importsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonFX dealersAre financial institutions that are licensed or authorised by the central banks of the countries in which they operateQuote two-way (i.e. buy and sell) pricesThere are also FX brokers who transact almost exclusively with FX dealersCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonCentral banksEnter FX market toPurchase foreign currency to pay for imports or interest on foreign debtChange the composition of holdings of foreign currenciesInfluence the exchange rateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonInvestors and borrowersCommercial bank foreign borrowings are usually converted into the home currencyCorporations and financial institutions investing overseasNeed to purchase FX in order to make the investmentsDividends or interest payments received from overseas investments will be denominated in a foreign currencyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonSpeculative transactionsBusinesses and financial institutions may attempt to anticipate future exchange rate movements to make a profitThere is a risk involved that the exchange rate will either moveIn the opposite direction to that anticipatedIn the anticipated direction but by less than expectedCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonSpeculative transactions (cont.)ExampleIf, today:Spot rate: USD1= AUD1.65Exchange rate expected today + n days: USD1= AUD1.70Then, today:Buy USD1 at a cost of AUD1.65Then, at today + n days:Sell USD1 and obtain AUD1.70Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonArbitrage transactionsProfit is made through FX transactions that involve no FX risk exposureTypes of arbitrageLocational—where two dealers quote different rates on the same currencyTriangular—occurs when exchange rates between three or more currencies are out of perfect alignmentCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonArbitrage transactions (cont.)Example: Triangular arbitrage USD1 = AUD1.65 USD1 = SGD1.65 AUD1 = SGD 0.97 Arbitrage strategy Sell AUD1.65 and receive USD1 Sell USD1 to receive SGD1.65 Sell SGD1.65 to receive AUD1.70Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.3 Operation of the FX MarketThe FX marketIs a global market, operating 24 hours a day according to business hours across the time zonesConsists of a vast and highly sophisticated global network of telecommunications systems that provide the current buy and sell rates for various currencies in dealing rooms located around the globeCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.4 Spot and Forward TransactionsFX market instruments are typicallySpot transactionsHave maturity date two business days after the FX contract is entered intoe.g. used if an Australian importer has an account in USD to pay within the next few daysForward transactionsHave maturity date more than two days after FX contract is entered intoe.g. used if Australian importer has to pay a USD liability in 2 monthsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.4 Spot and Forward Transactions (cont.)Dealers may also provide short-dated transactions if necessary‘Tod’ value transactions: same-day settlement‘Tom’ value transactions: settlement tomorrowCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market QuotationsAsking for a quotationThe price of currency is expressed in terms of another currencyThe first currency mentioned is the price being sought (also called base currency or the unit of quotation)The second currency is the terms currencyExample: USD/AUD is the price of 1 US dollar in terms of Australian dollarsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market Quotations (cont.)Two-way quotationsExample: Australian dollar/euro may be expressed as AUD/EUR1.8155–1.8165, usually abbreviated to AUD/EUR1.8155–65The two numbers indicate the dealer’s buy and sell priceThe dealer will buy AUD1 for EUR1.8155The dealer will sell AUD1 for EUR1.8165Dealer ‘buys low’ and ‘sells high’The difference between the buy and sell price is the ‘spread’Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market Quotations (cont.)Transposing spot quotationsExample: Given a quotation of AUD/EUR1.8275–1.8285 the EUR/AUD quotation can be determined by transposing the quotation i.e. ‘reverse and invert’ Reverse the bid and offer prices: 1.8285–1.8275 Then take the inverse (divide both numbers into 1) 1.000 1.000 1.8285 1.8275 EUR/AUD0.5469–0.5472Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market Quotations (cont.)Calculating cross-ratesAlmost all currencies are quoted against the USD and when transactions occur between two non-USD currencies the cross-rate needs to be calculatedThe procedure for calculating the cross-rate varies depending on whether the USD is aDirect quote—the USD is the base currency, orIndirect quote—the USD is the terms currency and the other currency is the base currencyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market Quotations (cont.)Example 3:Crossing two direct FX quotations.USD/EURO 9850 – 60USD/JPY 11 540 – 50To determine the EUR/JPY cross-rate:118.40/0.9880 = 117.0411550/0.9850 = 117.26EUR/JPY 117.05 – 26Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market Quotations (cont.)Example 4:Crossing a direct and indirect FX quotation.USD/JPY 115.40 – 50GBP/USD 1.5770 – 80To determine the GBP/JPY cross-rate:1.5570 x 115.40 = 181.991.5780 x 115.50 = 182.26GBP/JPY 181.99 – 182.26Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.5 Spot Market Quotations (cont.)Example 5:Crossing two indirect FX quotations.AUD/USD 0.5560 – 70GBP/USD 1.5770 – 80To determine the AUD/GBP cross-rate:0.5560/1.5780 = 0.35230.5570/1.5770 = 0.3532AUD/GBP 0.3523 – 32Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market QuotationsForward pointsThe forward exchange rate is the FX bid/offer rates applicable at a specified date beyond the spot value dateThe forward exchange rate varies from the spot rate due to interest rate parityInterest rate parity is the principle that exchange rates will adjust to reflect interest rate differentials between countriesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Forward points (cont.)Forward exchange rates are quoted as forward points either above or below the spot rateForward points represent the forward exchange rate variation to a spot rate baseIf the forward points are rising, then add them to the spot rate (i.e. forward premium)If the forward points are falling, then subtract them from the spot rate (i.e. forward discount)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Forward points (cont.) Example: Given AUD/USD (spot) 0.6930–0.6940 and six-month forward points: 0.0032–0.0027 Then, since the forward points are falling, subtract them from the spot rate to obtain the six-month forward rate of 0.6898–0.6913Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Forward points (cont.)Equations 15.2 and 15.3 in the textbook demonstrate how a FX dealer calculates the bid offer forward pointsThese equations take into accountInterest rates in the two countriesThe difference between bid and offer exchange rates i.e. spreadExample 6 illustrates the application of equations 15.2 and 15.3Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Example 6: An FX dealer is to calculate the bid and offer six-month forward points for the EUR/USD and has the following information. Bid OfferSpot EUR/USD 0.9850 0.98556-month US interest rates 5.60% 5.75%6-month euro interest rates 3.85% 4.00%Bid forward pointsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Example 6 (cont.):Offer forward pointsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Forward exchange contractsFX dealers quote forward points on standard delivery dates, usually monthly out to 12 monthsFor a non-standard delivery period, a dealer will calculate the forward rate taking into account the current spot rate, domestic and foreign interest rates and days in year as indicated in equation 15.4Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Forward exchange contracts (cont.)(15.4)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.6 Forward Market Quotations (cont.)Some ‘real world’ complicationsThe equations and examples illustrated are simplified and do not take into account complexities of the ‘real world’ financial markets likeDifferential interest rate basisInterest withholding taxTwo-way quotationsCompound interest periodCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.7 European Monetary Union (EMU)Currently, 12 of the 15 members of the EU are participants in EMUAs the EMU gains acceptance, the size and liquidity EMU member equity and bond markets will increaseThe EURO has become a hard currency like the USD in that it is generally accepted in international trade transactionsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation15.1 Introduction15.2 FX Market Participants15.3 Operation of the FX Market15.4 Spot and Forward Transactions15.5 Spot Market Quotations15.6 Forward Market Quotations15.7 European Monetary Union15.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson15.8 SummaryFX market participants include companies, dealers, central banks, investors, speculators and arbitrageursFX market instruments are usually either spot or forward transactionsWhich involve the quotation of the dealer’s buy-sell pricesCross-rates calculations are necessary between 2 non-USD currenciesForward exchange rates are quoted as forward points either above or below the spot rateCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson